To track the intended -- and more importantly, unintended -- consequences of policies,market movements,buyout deals and regulatory censure. This forum will map the multiplier effect of what may seem minor events initially but spread out far and wide.

10/31/2010

G-20's currency accord: a truce or a fig leaf agreement?

Days after the G20 hammered out a global accord for currency management, economists are unsure if this fragile agreement will address trade imbalances in the face of unclear policy targets, an increasingly assertive Chinese leadership and a possible increase in dollar supply by the US government – factors that can undo any international cooperation.

The finance ministers and central bank governors of G-20 signed off an agreement in Seoul on Oct 23 to “resist from all forms of protectionist measures” and “refrain from competitive devaluation of currencies,” according to a statement on its official website.

The efforts to avert an escalating currency war, however, fell short of specifying clear targets for countries’ current account surpluses or deficits and left a lot to moral suasion. Heads of these G20 states will now meet three weeks later in November to flesh out the details of these difficult adjustments.

Calling it “a fig leaf agreement”, Kenneth Goldstein, economist with New York-based think tank The Conference Board said in an email, “The G20 communique is just a way to put a face on the lack of agreement on what the real problem is (and) therefore, what solutions should be pursued.”

Singapore-based Todd Elmer, who heads the forex strategy –Asia in CitiGroup wrote in a note soon after the G-20 agreement that the agreement “fell well short of some market expectations for a Plaza-style accord”.

China took the sting out of some criticism surrounding it. On October 20 and days before the G20 meeting, it raised its benchmark one year lending and deposit rates by 25 basis points signalling it was willing to be more accommodative but the dragon nation, with its new found assertiveness on global forums, is unlikely to bend too far for too long if it sees other nations defecting on their promise.

The US Federal Reserve is widely speculated to resume buying of bonds in its November 2-3 meeting. Its chairman Ben Bernanke publicly said on October 16 that a slow recovery, high levels of unemployment and a below-target inflation rate made “a case for further action.

Called ‘quantitative easing’ (QE), this policy action of buying bonds will increase US dollar supply, stoke inflation and make dollar cheaper against other currencies – an outcome that runs effectively counter to US’ demand in G20 that other nations don’t devalue their currencies even as it does so implicitly, in its domestic market.

The official G20 statement specified that all countries will follow “monetary policy which is appropriate to achieve price stability” and advanced economies, with reserve currencies – a pointed reference to the US dollar – will “be vigilant against excess volatility and disorderly movements in exchange rates.”

Even though “it seems the U.S. had to agree to refrain from devaluing the dollar”, wrote Chris Turner, head of forex strategy with ING Commercial Banking in London in his Monday report, he " doubt(ed) the market will run very far with the view that the Fed will, because of this G20 agreement, choose to avoid QE measures in early November.”

There are already murmurs of disapproval that could endanger this hastily stitched global pact. The overseas edition of the People’s Daily in mid-October carried a commentary fromLi Xiangyang, an economist at the Chinese Academy of Social Sciences saying: “It is the dollar that triggered the currency war” and “given a sluggish economy and huge amount of debts, driving the value of the dollar down is in line with America’s interests, both in short term and in long term. The international community ought to stay vigilant.”

Cheaper currency makes a nation’s exports more competitive and brings in greater revenues but if pursued by several countries, such competitive devaluation drags everyone down. An October 11 report by Dutch NIBC Bank N.V. had said at least 18 countries intervened in their foreign exchange markets in the past few weeks – it admitted to have possibly undercounted this tally -- setting off a new age version of the “beggar thy neighbour” game.

Aligning these pitted national interests will be the biggest challenge as the head of states meet in November to conclude this process, even though some say any agreement is preferable to none at all.

An October 22 report by the French bank BNP Paribus conceded as much: "(although) the chances of an agreement on forex rates (at the November G20 meeting are) small...there will be a lot to lose should the G20 agree to disagree."